My Book Argued That Obama “Fumbled the Recovery.” Here’s What I Got Wrong.

November 3, 2014

President Barack Obama got endless guff for pointing out the obvious in early October—that his “policies are on the ballot” this Election Day even if he isn’t. Judging from the most recent polls, those policies aren’t wildly popular. The more important question is whether they were wise.

It’s fair to say I have a special obligation to grapple with this question, since back in 2012 I published a book about the Obama administration’s efforts to heal the economy. The book was largely a narrative, reconstructing events and internal debates as they unfolded. But it delivered a judgment on Obama’s economic team, and the judgment wasn’t favorable. Right there in the book’s subtitle it says that “Obama’s team fumbled the recovery.”

This probably sounds right to anyone who’s unemployed, particularly anyone who’s been among the painfully large number of long-term unemployed. And really from any perspective, it’s hard to get too triumphalist about the recovery. The percentage of the population that’s employed—as opposed to the unemployment rate, which doesn’t pick up people who’ve dropped out of the labor force—is still substantially lower than in 2007. In fact, it’s as low as it’s been since the early 1980s. Likewise, today’s median household income is about $5,000 below its 2007 level. That’s about where it stood in 1995.

Having said that, I do think my verdict on the administration was overly harsh. Job growth has been very steady the last three years. GDP growth has exceeded two percent in each of the last two years, and will almost certainly do so again in 2014. More importantly, as Danny Vinik recently pointed out, the United States has emerged from the Great Recession much more quickly than other advanced economies. The unemployment rate across the European Union is still above 11 percent, higher than where it peaked in this country. In the United Kingdom, which voluntarily adopted Paul Ryan-esque austerity policies, you had to squint to see any economic growth for a few years, until the government eased up on its masochism.

And the same goes for historical comparisons. As Paul Krugman recently observed in Rolling Stone, the United States did a better job limiting the fallout from its financial crisis than the typical advanced economy has over the years. We also crawled our way out of the hole a little faster.

So where did I go wrong? My book made four major criticisms: That the initial stimulus was too small (and, more importantly, that the White House could have secured a somewhat bigger one); that the administration pivoted too quickly from trying to boost the economy with tax cuts and spending to worrying about the deficit; that the financial rescue, while effective in itself, paid too little attention to how the public perceived it; and that financial reform was exceedingly weak brew. Secondarily, I argued that health care reform was a diversion from boosting the economy, and that the administration was way too timid in its efforts to help homeowners.

Perhaps a little pig-headedly, I still believe most of those criticisms are right. My mistake was to assume Obama’s errors were strategic ones—errors that would doom the economy to years of slow growth and brutally high unemployment. In fact, most were not.

Consider the stimulus. As I reported in my book, Christina Romer, the first head of Obama’s Council of Economic Advisers, estimated that it would take a stimulus of about $1.8 trillion to drive the unemployment rate back down to 5 percent by 2011. The actual size of the stimulus Congress passed and Obama signed into law was around $800 billion—or about $1 trillion too little, according to Romer’s calculations.

This wasn’t fatal in itself. One reason the administration felt comfortable being so far below the ideal number is because some of its top economists, like Larry Summers, put stock in a concept called escape velocity. The idea is that the initial boost from the stimulus reinforces itself over time. As workers and businesses feel more confident, they spend more of their income and hire more employees, which leads to more confidence and more spending and hiring. As long as the stimulus was big enough to provide that initial boost, you wouldn’t necessarily need the full amount Romer worked out.

The problem with betting too heavily on escape velocity is that, if you don’t achieve it, then you’re really in trouble. You’ve got a too small stimulus and nothing propelling you forward. And, indeed, there were moments in 2011 when it looked like that’s what had happened. The economy shrank by 1.5 percent in the first quarter of that year. Unemployment was above 9 percent into the fall. I worried that we’d doomed ourselves to years of stagnation (or worse) on the back of some hair-brained theory.

But here’s the thing: In retrospect, the whole escape velocity thing ended up being a bit beside the point. I don’t think anyone could argue that we achieved escape velocity. We never got a huge acceleration in growth or hiring that reinforced itself over time. And yet the stimulus still worked pretty well: It kept the economy afloat while Americans found new jobs and rebuilt their finances. Gradually, they were able to start spending again. That process would have happened sooner had the stimulus been bigger. But the important thing is it happened.

The same goes from the administration’s collaboration with Republicans on deficit-reduction beginning in 2011. In theory, those efforts could have stamped out the recovery and triggered a second recession. In practice, Americans were already sufficiently far along in putting the pieces back together that the austerity mania only slowed the recovery, it didn’t derail it. That’s tragic and completely maddening—the sequester Obama agreed to when Republicans threatened a debt default cost millions of jobs—but it wasn’t catastrophic.1

The financial rescue provides its own interesting case study. In my book, I tell the story of a tense meeting in then-chief-of-staff Rahm Emanuel’s office in the fall of 2009. Emanuel was getting a bit frantic about the public’s anger toward the banks. He wanted to know what the administration could do to defuse it. The political hands in the room, like David Axelrod and Robert Gibbs, essentially said: “not much.” The government had given the banks hundreds of billions of dollars at a time when average people were really hurting. How did you expect them to feel about it? In return, Treasury Secretary Tim Geithner, the chief architect of the various bailouts, protested, “We didn’t give the banks any money. We forced them to go raise it.” He couldn’t believe Axelrod and Gibbs would descend so easily into crude populism.

My own feeling is that both sides had a point. Geithner and his team of emergency responders deserve real credit for ending the financial crisis—no small achievement. As I wrote in the book, the elaborate “stress test” exercise Geithner hatched “created confidence in the banking system at a time when confidence was lacking.” And, just as Geithner insisted in that meeting, the government forced the banks with shaky stress-test grades to go out and raise a lot of money. Better yet, it was money that diluted their shareholders and enforced a measure of justice.

But Axelrod and Gibbs were right in a broader sense. The government had given the banks trillions of dollars worth of guarantees and insurance policies and cheap loans, for which it never received anything approaching the market level of compensation. (And that’s when it received any compensation at all.) The average taxpayer surely didn’t understand the intricacies of all of this. But they could sense that huge sums of money had been handed over to the banks, whose economic fortunes were improving much more quickly than their own. They weren’t crazy to be pissed about it. Moreover, as I pointed out in the book, many on Wall Street—even some in Geithner’s own Treasury Department—believed there were ways of making banks shoulder more of the burden for their own bailouts. (For starters, the stress tests could have required slacker banks to raise even more money, diluting their shareholders further.) Geithner rejected almost all of them.

The result was a level of economic injustice that was morally offensive. It also, as Axelrod and Gibbs pointed out, was really pissing off voters. This, in turn, had the unfortunate effect of completely screwing Democrats in 2010, which led to a Republican majority in the House, which stopped much of Obama’s agenda and set the stage for his misbegotten grand-bargaining.

On the other hand, it’s hard to believe the House could have been saved in 2010 had Geithner et al been somewhat tougher on the banks—they were going to have to do a fair amount of unsavory bailing out any way they sliced it. Moreover, as noted above, even the loss of the House and the misguided focus on deficit reduction didn’t cripple the recovery. It only delayed it. In the end, it’s hard to see how this was a strategic mistake either.

That brings us to financial reform, which remains the least successful part of the Obama economic record. In his own reappraisal of Obama’s presidency, Krugman writes that the crisis “should have been followed by a drastic crackdown on Wall Street abuses, and it wasn't,” and that “Obama bears a considerable part of the blame for this disappointing response.” Still, he argues, “the Dodd-Frank financial reform bill is a lot better than nothing.”

I’d put it slightly differently—basically, I’d delete the words “a lot.” The best thing to come out of Dodd-Frank was the consumer financial protection agency that Elizabeth Warren championed, a real agency using its very real powers to improve people’s lives. The next best things to come out of the bill were the Volcker Rule, which prohibits federally-backed banks placing speculative bets (great idea, but in practice, it’s been a bit porous), and higher capital requirements, which increase the amount of money the banks must hold to cushion themselves against big losses. After that, there are a few marginally helpful reforms, like tougher regulation of derivatives, the financial instrument that blew up AIG, but they don’t go nearly far enough.

Once you step away from these marginal improvements, you see two fundamental problems. First, several banks are still way too damn big to manage. My book explains why at some length, but here’s an easy way to tell: During and after the financial crisis, JPMorgan CEO Jamie Dimon was widely regarded as the most exacting big-bank CEO of his cohort. But even Dimon had no idea what his traders were up to when they placed a several-billion-dollar losing bet in 2012.

Unfortunately, this fact colors almost every aspect of Dodd-Frank. For example, Krugman touts the government’s new authority to liquidate troubled megabanks the same way the FDIC does for community banks that fall apart. In theory, this should prevent a bailout—Geithner at al argued that they had no choice but to bail out Citigroup and Bank of America because they didn’t have the authority to wind them down, FDIC-style. In practice, however, there’s no way the government is going to put a megabank into receivership during the next financial crisis. It could take months to sort through the sprawling obligations of a bank that size, during which time the financial panic would have long since spread around the world. More likely, the government will deal with future Citigroups the way it dealt with AIG: give it an enormous loan in exchange for a huge ownership stake.

The second problem is related: The basic theory behind Dodd-Frank, which reflected Geithner’s philosophy, is that you prevent financial crises by giving regulators more powers, not by restructuring Wall Street. But if you don’t restructure—specifically, if you don’t create smaller, less complicated financial institutions—the new powers aren’t going to help the regulators a hell of a lot. The banks will retain their enormous political influence, allowing them to squeeze any congressman and regulator who gets too uppity. And they’ll be way too big and complicated for regulators to monitor, much less police.

These flaws, in turn, led to two serious consequences. First, the public has simply never believed the banks paid a meaningful price for their misbehavior, which created an enormous political headache for the Obama administration (see previous section). A tougher breed of financial reform might not have saved the House in 2010, but I guarantee it would have made it more competitive.

Second and more importantly, we’re almost certainly going to have another crisis in the next decade, probably a major one. Krugman says Dodd-Frank will make that crisis “less severe and easier to deal with.” I disagree. Dodd-Frank may make the next crisis somewhat less severe. But it will be far more difficult to deal with, for the simple reason that almost no one believes the banks or politicians learned their lesson from 2008, and so they’ll be far less keen on throwing the banks a lifeline. And they weren’t exactly excited about it the first time.

All the other mistakes Obama and his economic team made were painful, but essentially second-order and forgivable. In any case, it’s only fair to grade on a curve in a situation as challenging as the one Obama faced. Financial reform is the one exception. It’s the mistake we’ll be ruing for years.

Incidentally, this analysis also makes health care reform look much better in retrospect. If you were concerned, as I was, that the enormous time, energy, and political capital the administration spent on the Affordable Care Act were time, energy, and capital it wasn’t spending on keeping the economy from relapsing, then it seemed like a bad idea to do it so soon. If the upshot was to slow down the recovery rather than doom it, it suddenly becomes a much better tradeoff. The delayed recovery probably cost us a few million jobs over the course of a few years. Obamacare will improve the lives of tens of millions of people for decades to come. (Though, for the economics nerds out there, you have to “discount” the benefits that come far in the future.)

This piece originally stated that GDP growth remains anemic in the United Kingdom. It has been corrected to reflect the boost in growth during the past year.